Canada: Why Would Anyone Want An Unlimited Liability Company?

An unlimited liability company ("ULC") is a common entity US businesses use as a Canadian subsidiary or to hold Canadian assets.  This can seem strange.  Normally, a business will incorporate because shareholders do not incur liability for the corporation's debts and liabilities except in exceptional circumstances.  However, the shareholders of a ULC do incur liability for the corporation's debts and liabilities.  Why would anyone want to use a ULC if that is the case?  The reason is that ULCs offer several tax advantages to US shareholders.  Those tax advantages are discussed below after a brief discussion of the use of a branch or subsidiary to carry on business in Canada.

Branch Verse a Canadian Subsidiary

One of the first things a US business needs to decide upon when expanding into Canada is whether to operate a branch or form a Canadian subsidiary.  Operating a branch in Canada simply means the US business starts conducting business directly in Canada.

There are several drawbacks associated with a branch operation.  First, the US business will be a non-resident of Canada.  As such, it will be subject to a number of withholding tax rules.  All services provided in Canada by the US business will be subject to 15% Regulation 105 withholding tax.  Also Canadian source passive income, such as interest, rents and royalties, earned by the US business will be subject to Part XIII withholding tax which by default applies at a rate of 25% but may be reduced under the Canada-US Tax Convention.  Also any taxable Canadian property, which includes land and buildings, will be subject to Section 116 withholding tax and related rules.   Second, a US business carrying on business in Canada will be required to file a Canadian income tax return and generally be exposed to Canadian tax obligations.  Third, the US business may also be required to register for and comply with the goods and services tax / harmonized sales tax ("GST/HST") and, in the case of British Columbia, Saskatchewan and Manitoba, provincial sales tax ("PST"). 

US businesses often form a Canadian corporate subsidiary in order to avoid the above consequences.  The Canadian corporation will be a resident of Canada, which will prevent the withholding tax rules cited above from applying as such rules apply to non-residents.  Another advantage of a Canadian subsidiary is that the subsidiary will bear the Canadian tax obligations rather than the US parent.  It will be the Canadian subsidiary that will file a Canadian income tax return and comply with GST and PST requirements.

Unlimited Liability Companies

US businesses have two choices when incorporating a Canadian subsidiary.  The subsidiary can either be an ordinary corporation whose shareholders have limited liability or an unlimited liability company.  As the name implies, a ULC's shareholders face liability.  The shareholders of a ULC incorporated under British Columbia law will be liable for the ULC's debts and liabilities if the ULC liquidates or dissolves and cannot pay such debts and liabilities.  Former shareholders can also be liable in specific circumstances.  Despite the lack of limited liability, US businesses have for years used ULCs as Canadian subsidiaries and to hold Canadian assets.  The reason being that ULCs offer favourable tax outcomes. 

The following discussion of the favourable tax treatment of ULCs assumes that a US corporation is the sole shareholder of the ULC.  In such circumstances, the ULC will be disregarded as an entity separate from its shareholder unless it elects otherwise.  The fact the ULC is disregarded enables the consolidation of the ULC's income with that of its US parent.  The consolidation of income generally enables the US parent to claim foreign tax credits in the US to offset Canadian tax paid by the ULC.  This structure may enable a US parent with a ULC subsidiary to pay less total tax than if the US parent used an ordinary corporation as a subsidiary.

Another advantage of using a ULC is that retained earnings can be repatriated to the US parent with only 5% withholding tax which may also be offset by a foreign tax credit.  However, the repatriation has to be done by way of a two-step distribution which is discussed below.

Two-Step Distribution

The following assumes a US corporation is the sole shareholder of a ULC and satisfies the limitation on benefits provision of the Canada-US Tax Convention.  If that is the case, retained earnings of the ULC can be repatriated to the US parent with only 5% Part XIII withholding tax applying to the distribution.  While the end result is simple to understand, the mechanism by which to implement it can be confusing.  To understand the mechanism, you must first understand what happens if a ULC pays an ordinary dividend to its US parent. 

Dividends paid by a Canadian corporation to a non-resident are subject to 25% Part XIII withholding tax.  However, the rate of withholding tax may be reduced under Canada's bilateral tax treaties.  Based on the assumptions made above, the rate would be reduced to 5% under the Canada-US Tax Convention if not for an anti-avoidance rule contained in Article IV(7)(b) of that treaty. 

Article IV(7)(b) is an anti-avoidance rule that applies to entities known as hybrids.  A hybrid is an entity that is considered a taxpayer in one state and fiscally transparent in another.  Fiscally transparent means that the entity itself does not incur tax obligations in regards to its income.  Instead, its owners incur the tax obligations.  A ULC is a perfect example of a hybrid.  For Canadian tax purposes, a ULC is considered a taxable Canadian corporation.  For US tax purposes, it is by default treated as a disregarded entity (if it has one shareholder) or a partnership (if it has more than one shareholder). 

The different treatment of hybrids in different countries can be exploited to reduce tax in abusive ways.  In order to stop that, Canada and the US added Article IV(7)(b) to the latest version of the Canada-US Tax Convention.  In summary, Article IV(7)(b) prevents treaty benefits from applying if (1) the "Source State" (i.e., the country from which amounts are paid) views the payee as receiving the amount from a payer resident in the Source State; (2) the payer is treated as fiscally transparent under the law of the "Residence State" (i.e., the country in which the payee is resident); and (3) because of the payer being treated as fiscally transparent under the law of the Residence State, the treatment of the amount received by the payee is not the same as its treatment would be if the payer were not treated as fiscally transparent under the law of the Residence State.

Dividends paid by a ULC to its US parent fall squarely within the Article IV(7)(b) anti-avoidance rule, preventing a reduction of the 25% Part XIII withholding tax.  The reason being is that (1) Canada views the US parent as receiving the dividend from a corporation resident in Canada; (2) the ULC is treated as fiscally transparent in the US; and (3) since the ULC is treated as fiscally transparent, the dividend is disregarded for US tax purposes whereas it would not be disregarded if the ULC were not treated as fiscally transparent.

Article IV(7)(b) is generally understood to be broader than necessary, catching transactions that are not abusive tax avoidance.  A ULC distributing retained earnings to its US parent is understood as one of the instances where Article IV(7)(b) catches a transaction that is not abusive.  Presumably the Canada Revenue Agency ("CRA") agrees with that analysis, as it has sanctioned a method to circumvent Article IV(7)(b) and to allow retained earnings of a ULC to be repatriated with only 5% withholding tax applying to the distribution.  The method is commonly known as a two-step distribution.  Once again, the following discussion is based on the assumptions made at the beginning of this section.

As the name implies, a two-step distribution involves two steps.  The first step requires the ULC to increase the paid-up capital ("PUC") on a class of its shares by capitalizing retained earnings.  PUC of a class of shares generally equals the capital, for corporate law purposes, of that class of shares.  So, the capitalization of retained earnings under corporate law increases PUC by the amount capitalized.  In the case of a British Columbia ULC, retained earnings can be capitalized by a directors' resolution or an ordinary resolution of the shareholders.

The increase in PUC on a class of shares by capitalizing retained earnings triggers a "deemed dividend" on those shares for purposes of Canadian taxation.  The amount of the deemed dividend equals the increase in PUC.  The amount of the deemed dividend is subject to Part XIII withholding tax.  However, the rate will be reduced to 5% under the Canada-US Tax Convention.  You may wonder why the anti-avoidance rule in Article IV(7)(b) does not apply to deny treaty benefits.  The reason is that the deemed dividend would be disregarded for US tax purposes regardless of whether the ULC is fiscally transparent or not.  Therefore, the third requirement of the Article IV(7)(b) anti-avoidance rule is not satisfied, and the rule is not applicable.

The second step requires the ULC to reduce its newly created capital and distribute that amount to its US parent.  In the case of a British Columbia ULC, a reduction of capital is done by way of a special resolution of the shareholder.  A reduction of capital on a class of shares does not give rise to Canadian taxation provided the reduction does not exceed the amount of PUC on that class of shares.  So, the ULC will be able to return capital to its US parent without triggering further tax provided the amount returned does not exceed the amount of retained earnings capitalized in step one.  The return of capital generally does not trigger US taxation.

Limited Liability Companies

Using a ULC can be an effective strategy for US C Corporations, S Corporations or partnerships although the tax implications are somewhat different in each case and should be discussed with a tax advisor.  However, a fiscally transparent US LLC should generally not use a ULC as a subsidiary because repatriated earnings of the ULC will be subject to 25% Part XIII withholding tax.  An LLC is fiscally transparent unless it has elected to be treated as a corporation for US tax purposes.

The CRA's position is that a fiscally transparent LLC does not qualify as a US resident for purposes of the Canada-US Tax Convention.  The CRA's reasoning is that a fiscally transparent LLC does not fall within the definition of "resident of a Contracting State" because such an LLC is not itself liable to tax in the US.  Based on that reasoning, the CRA denies treaty benefits to a fiscally transparent LLC because only a resident of a Contracting State is entitled to treaty benefits. 

Under Article IV(6) of the Canada-US Tax Convention, a fiscally transparent LLC may be able to indirectly access treaty benefits if its members would be eligible for the benefits.  However, a condition of Article IV(6) applying is that the members of the LLC are "considered under the taxation law of [the US] to have derived the amount through an entity [i.e., the LLC]".  The CRA's position is that a member of an LLC cannot be considered to have "derived" an amount under US tax law from the LLC if that amount originated from a ULC.  The CRA's position is based on the fact that amounts distributed from the ULC are disregarded for US tax purposes.

In summary, the CRA's position is that an LLC is not eligible for treaty benefits either directly or by way of Article IV(6) if the amount in question originated from a ULC.  Therefore, 25% Part XIII withholding tax applies on dividends paid or deemed to be paid by a ULC to its LLC shareholder, and the amount of withholding tax cannot be reduced under the Canada-US Tax Convention.


Given the complexities involved, US businesses thinking of expanding into Canada should put serious thought into how to structure their Canadian operations. US businesses should consult with both Canadian and US tax advisors.  In particular, US businesses should consult a US tax advisor to confirm that the US tax benefits associated with a ULC discussed above are available in their particular circumstances.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Similar Articles
Relevancy Powered by MondaqAI
Moodys Gartner Tax Law LLP
In association with
Related Topics
Similar Articles
Relevancy Powered by MondaqAI
Moodys Gartner Tax Law LLP
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions